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Lease payments are the amounts a lessee pays to a lessor for the right to use an asset during the lease term. These payments include not only the fixed monthly or annual rent but also variable payments tied to an index or rate, optional purchase exercise prices if you are reasonably certain to exercise them, and penalties for terminating early if the lease term reflects a termination option. Under modern accounting standards, lease payments are the inputs that determine how large a liability you must record on your balance sheet.
Before IFRS 16 took effect in January 2019, most operating leases stayed off the balance sheet entirely. You disclosed them in footnotes. Under IFRS 16, virtually every lease with a term over 12 months requires you to record both a right-of-use asset and a lease liability equal to the present value of future lease payments.
This change made lease obligations visible to investors who were previously estimating them from footnote disclosures alone. It also raised the gearing ratios of any company with significant leasing activity.
Fixed payments are the contractually required amounts you pay each period regardless of how you use the asset. They form the core of the lease liability.
Also included are in-substance fixed payments: amounts that appear variable in name but are effectively unavoidable in practice. If a lease clause requires you to pay a minimum of $1 million per year even if usage falls below a certain threshold, that is treated as a fixed payment in the liability calculation.
Not all variable payments go into the lease liability. IFRS 16 distinguishes between two types.
Because the lease liability must be measured at present value, you need a discount rate. IFRS 16 requires you to use the rate of interest implicit in the lease if you can determine it. If you cannot, you use your incremental borrowing rate: the interest rate you would pay to borrow the same amount over the same period with the same collateral.
For a 10-year lease with annual payments of $10,000 and a 6% discount rate, the initial lease liability is approximately $73,600. That is the number that appears on the balance sheet, not $100,000.
IFRS 16 allows two practical exemptions that let you keep lease payments off the balance sheet and expense them straight through the income statement. The short-term lease exemption applies to leases with a term of 12 months or less. The low-value asset exemption applies to leases of items like tablets, personal computers, and small office equipment.
These exemptions are significant for companies with large fleets of small leased assets. Without them, every laptop lease would require its own present value calculation.
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